Controlling China’s Currency

China is stuck in a currency-creating cycle: GDP growth encourages investment, which boosts demand for capital, creates liquidity, and stimulates further GDP growth. The key to controlling the money supply is to prevent the government from becoming a second currency-creating body.

BEIJING – It is indisputable that China is over-issuing currency. But the reasons behind China’s massive liquidity growth – and the most effective strategy for controlling it – are less obvious.

The last decade has been a “golden age” of high growth and low inflation in China. From 2003 to 2012, China’s annual GDP growth averaged 10.5%, while prices rose by only 3% annually. But the unprecedented speed and scale of China’s monetary expansion remain a concern, given that it could still trigger high inflation and lead to asset-price bubbles, debt growth, and capital outflows.

Data from the People’s Bank of China (PBOC) show that, as of the end of last year, China’s M2 (broad money supply) stood at ¥97.4 trillion ($15.6 trillion), or 188% of GDP. To compare, M2 in the United States amounts to only roughly 63% of GDP. In fact, according to Standard Chartered Bank, China ranks first worldwide in terms of both overall M2 and newly issued currency. In 2011, China accounted for an estimated 52% of the world’s added liquidity.

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